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Gloomy Outlook Looming Over Engineering R&D Services Industry

Shrabana Mukherjee

The Zacks Engineering – R&D Services industry primarily consists of engineering and infrastructure service providers. The companies basically provide construction, technical, engineering and professional services to a number of industries worldwide, including oil and gas, chemical and petrochemicals, transportation, mining and metals, power, agriculture, consumer applications and manufacturing.

Some of the prominent players in this industry are Quanta Services, Inc. (PWR), Jacobs Engineering Group Inc. (J), KBR, Inc. (KBR), Fluor Corporation (FLR) and AECOM (ACM).

Let’s take a look at the industry’s three major themes:

  • Increasing construction activities in residential and government projects in the United States — that require state-of-the-art construction and engineering services — are expected to benefit the construction and engineering services industry. Other tailwinds include the rapid usage of advanced technologies to deliver smart buildings and mega projects, while identifying and checking margin contraction and costs.
     
  • The Trump administration’s investment in defense and cyber security is conducive to the industry’s growth. The players are also gaining from rising global demand for alternative nuclear energy, as they provide engineering, procurement, construction and maintenance services to nuclear power plants. Meanwhile, increasing public investments in transportation, water infrastructure, utility plant and healthcare market are anticipated to drive the industry’s growth. In addition, infrastructure services business of the industry players continues to thrive, supported by robust demand from the communications industry. Chemical derivative and refining opportunities, both domestic and international, along with upstream and LNG opportunities should also spur growth.
     
  • However, slowing global growth, a tight labor market, trade-war induced rise in raw material costs, volatility in commodity prices and the cyclical nature of the industry’s commodity-based business lines pose significant challenges. Some of the companies have also been witnessing a dearth of larger pipeline projects owing to volatility in consumer spending. Again, significant cost overruns (as prices of several companies’ contracts are fixed) have been hurting the bottom line of some of the companies. Increasing competition is another dampener. The industry faces intense competition in the global engineering, procurement and construction industry, which is detrimental to companies’ contract prices and profit margins.


Zacks Industry Rank Indicates Dull Prospects

The Zacks Engineering – R&D Services industry is a 17-stock group within the broader Zacks Construction sector. The industry currently carries a Zacks Industry Rank #227, which places it at the bottom 11% of more than 250 Zacks industries.

The group’s Zacks Industry Rank, which is basically the average of the Zacks Rank of all the member stocks, indicates dismal near-term prospects. Our research shows that the top 50% of the Zacks-ranked industries outperforms the bottom 50% by a factor of more than 2 to 1.

Despite the industry’s gloomy near-term view, we will present a few stocks that one can hold on to. Before that, it’s worth taking a look at the industry’s shareholder returns and current valuation.

Industry Underperforms S&P 500 & Sector

The Zacks Engineering – R&D Services industry has lagged the Zacks S&P 500 composite and the broader Zacks Construction sector over the past year.

Over this period, the industry has gained 20.4% versus the broader sector’s rally of 34.9%. Meanwhile, the S&P 500 has gained 25%.

One-Year Price Performance

 
 
Industry’s Current Valuation

On the basis of forward 12-month price-to-earnings ratio, which is a commonly used multiple for valuing Engineering – R&D Services stocks, the industry is currently trading at 14.5X versus the S&P 500’s 19.1X and the sector’s 16X.

Over the past five years, the industry has traded as high as 16.9X, as low as 9.9X and at the median of 13.1X, as the chart below shows.

Industry’s P/E Ratio (Forward 12-Month) Versus S&P 500

 


Bottom Line

A major boost in infrastructural and construction spending (mainly residential and government projects) should continue to favor the industry’s performance. Advanced construction and engineering services along with prudent cost management practices should lend support. However, a tight labor market, slowing global growth and uncertainty around global trade are pressing concerns.

Below we present only one stock from the Zacks Engineering – R&D Services space with a Zacks Rank #2 (Buy). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

AECOM: This Los Angeles, CA based company engages in designing, building, financing and operating infrastructure assets worldwide. The stock carries a Zacks Rank #2 and its earnings for 2020 are expected to grow 20.4%. It has a three-five year expected EPS growth rate of 12.4%.

Price & Consensus: ACM


Investors can also consider the following stocks with good prospects.

Fluor Corporation: Headquartered in Irving, TX, this Zacks Rank #3 (Hold) company delivers engineering, procurement, construction, maintenance and project management to governments and clients in diverse industries around the world. Earnings for 2020 are expected to grow 116.6%.

Price & Consensus: FLR



Quanta Services, Inc.: This Houston, TX-based company provides specialty contracting services to the electric power, communication, and oil and gas industries in the United States, Canada, Australia, Latin America and internationally. This Zacks Rank #3 company has an expected earnings growth rate of 20.9% for 2020. It has a three-five year expected EPS growth rate of 14.5%.

Price & Consensus: PWR



Below are two stocks with a bearish Zacks Rank that we would recommend investors to stay away from for the time being.

Apergy Corporation (APY): The Woodlands, TX-based company provides engineered equipment and technologies. The consensus EPS estimate for this Zacks Rank #5 (Strong Sell) company has decreased 11.7% to 98 cents for 2020, over the last 60 days.

Price & Consensus: APY



Gates Industrial Corporation plc (GTES): Headquartered in Denver, CO, this company manufactures and sells engineered power transmission and fluid power solutions worldwide. It currently carries a Zacks Rank #4 (Sell) and the consensus estimate for 2020 EPS has decreased 1% to 99 cents, over the last 30 days.

Price & Consensus: GTES



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Quanta Services, Inc. (PWR) : Free Stock Analysis Report
 
KBR, Inc. (KBR) : Free Stock Analysis Report
 
Jacobs Engineering Group Inc. (J) : Free Stock Analysis Report
 
Gates Industrial Corporation PLC (GTES) : Free Stock Analysis Report
 
Fluor Corporation (FLR) : Free Stock Analysis Report
 
Apergy Corporation (APY) : Free Stock Analysis Report
 
AECOM (ACM) : Free Stock Analysis Report
 
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